Weekly commentry

Weekly Commentary

Economy: Even though it is expected that the US Federal Reserve will not raise interest rates at its 22 August meeting it is now expected the RBA will raise rates at its September 5 meeting. The RBA is concerned about the rapid rise in credit growth, continuing strong employment growth, rising consumer confidence and inflation which is at the top of the 2% to 3% target range. Rising interest rate expectations coupled with firm commodity prices has given the A$ a lift to above US$0.59. Equities: The Australian All Ordinaries index finishes at a record high of 3,297 points, despite the markets concerns about rising interest rates, preferring to focus on the continuing positive outlook for world growth, commodity prices and the positive company earnings outlook. Tight equity supply compounded by the lack of new IPO’s, share buy backs and takeovers are also placing upward pressure on the domestic equity market at the time when fund managers are flush with cash. All these factors should lead to a stronger equities in the coming months.

Capital Flows

The Australian Small Industrial market, inline with the broarder market, continued to recapture gains over the week ending Thursday 17 August. The Small Industrials Index closed up 33 points at 2283 a gain of 1.5% whilst the All Ordinaries gained 0.7%. Volumes, however, after starting to build through June and July started to drop last week and continued to fall over the week just finished. The lower volumes reflect hesitancy, particularly on the part of retail investors given the low news flow, a focus on the reporting season and interest rate uncertainty.

The success of recent floats does however, reinforce the view that superannuation changes and renewed international interest has left a lot of money looking for fresh ideas amongst Australian growth companies.

Two weeks into reporting season, results are coming through largely inline with BNPPE expectations. Of our preferred growth stocks, those that have reported are meeting or exceeding expectations. We are therfore increasingly confident of there FY01 outlook and on a twelve-month time horizon expect further out performance.

Focus on Franking Credits

Following the savage global correction in high technology and telecommunications stocks the market has turned its focus back to defensive stocks – the "old economy" blue chips and high yielding stocks in general. This move has been reinforced by a new tax ruling in relation to excess franking credits. From the end of last month, excess-franking credits will be refunded by the tax office, rather than simply lost or used to offset other income. This means that investors will now be able to gain the full benefit of franking credits attached to dividends or capital returns.

The reduction in company tax rate from 36% to 34% at the end of June 2000, and a further reduction to 30% after June 30 2001, is expected to lead to an increase in special dividends/capital returns over the next 12 months. This is because companies that have accumulated substantial franking credits at the higher rates seek to maximise the franking benefits for shareholders.

Companies that might be expected to pay substantial fully franked dividends/capital returns over the next 12 months, either because they have accumulated significant franking credits or because of special situations, include Capral, Lend Lease and Coles Myer.

The correction in technology stocks has gone a long way to restoring some semblance of value to many technology, growth and telecommunications stocks.

Economic Roundup.

The Australian economy has now run for a record nine years with only one-quarter in which GDP failed to expand. At the start of this year, all the signs pointed to another stellar growth performance – which is why the Reserve Bank started tightening monetary policy in November 1999.

With the 2 August rise, the Reserve Bank has lifted the cash rate from a record-equalling low of 4.75% to just 6.25%. It made its latest move because the weakness in consumer/business confidence/spending in the first half of the year seems to have passed, except for housing.

Now that growth is back on track (the RBA mentioned whatever slowing there is in domestic spending is being offset by strong exports), inflation pressures are more acute - high oil prices, rising non-wage costs, the GST, the low $A and a tightening labour market.

Further increases in Australia interest rates are likely over the next 6 months.

Equity markets do not usually perform well when interest rates rise so caution is warranted particularly for interest rate sensitive industrial stocks. However, with healthy economic growth, and a likely peak in rates by Christmas, interest-sensitive sectors (banks, insurers, property trusts and infrastructure/utilities) are attractive on a 12-month view.

Other positives for equities are that the industrial side of the market is about fair value relative to current bond yields, local institutions are cashed up and offshore institutions are mostly underweight Australian assets. Resources sector remains undervalued relative to current commodity prices, especially with tight supply for many commodities, a low $A enhancing local companies’ international competitiveness and buoyant takeover activity.

In general, investors are likely to retain a degree of caution and hence favour "old Economy" defensive stocks as well as financials, utilities, infrastructure and the large cap resource companies. In the technology sector, best buys are among stocks that: (i) actually make profits or (ii) have a sound business model and reasonable chance of making profits. The more speculative end of the technology market is more of a gamble for most investors.

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